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The American Prospect - articles by authorenSocial Security on the Tablehttp://prospect.org/article/social-security-table
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<p></p><p><font size="+3">S</font>uddenly, Social Security is no longer sacrosanct.<br />
Critics say the program is going bankrupt, about to be overwhelmed by the<br />
graying of the baby-boom generation. Many young workers have little confidence<br />
that Social Security will be there when they retire. This, in turn, has invited<br />
an unprecedented discussion of radical structural changes. For the first time,<br />
the official Social Security Advisory Council is offering three wide-ranging<br />
proposals for restructuring. All three envision investing some Social Security<br />
funds in private financial markets. Two of the three would create, for the first<br />
time, individual investment accounts financed with Social Security payroll<br />
charges. </p><br /><p>This is a remarkable turnabout, substantively and politically. In 1983, the<br />
last time Social Security's finances were shored up, so strong was the support<br />
for the existing system that advocates of privatization on the Reagan White<br />
House staff were kept far from the deliberations. In the 1992 presidential<br />
election, all candidates repeated the quadrennial ritual of swearing fealty to<br />
America's most expensive and popular social program. But suddenly, the idea that<br />
a portion of one's Social Security taxes could fund an individual retirement<br />
account seems to combine political appeal for baby boomers with the prospect of<br />
stabilizing the system's finances and perhaps raising America's low rate of<br />
private saving as well.</p><br /><p>In what follows, we set the stage for understanding why Social Security is<br />
suddenly in play, the dimensions of its financial problems, and the logic of the<br />
three reform proposals. What, after all, are the goals of the Social Security<br />
program? How well has it met them in the past and can it do so in the future? Is<br />
privatization desirable or necessary?</p><br /><hr /><br /><h3>SOCIAL SECURITY IN PERSPECTIVE</h3><br /><p>Social Security, by design, is unlike any private insurance or retirement<br />
plan. It combines a nearly universal pension program with a highly<br />
redistributive income transfer program as well as an insurance policy offering<br />
disability and survivorship benefits. In contrast to nearly all private pension<br />
plans, it is also totally portable and fully indexed for inflation. Because of<br />
its inclusiveness, Social Security has been immensely popular since its<br />
inception. </p><br /><p>In 1995, Social Security benefits exceeding $330 billion were distributed to<br />
more than 43 million recipients and their families under the old-age, survivors<br />
and disability programs (OASDI), accounting for over one-fifth of all federal<br />
government spending. The average benefit was about $7,700 per year. Payroll<br />
taxes totaling $365 billion were collected from 141 million workers, averaging<br />
about $2,600 per covered worker. Besides payroll taxes, 1995 Social Security<br />
revenues included $6 billion in receipts from part of the income taxation of<br />
Social Security benefits (the other part supports Medicare), and another $35<br />
billion in interest earned on accumulated reserves. Currently, the agency's<br />
revenues exceed expenditures by about $60 billion per year. </p><br /><p>Although these reserves are large and growing (about $500 billion at the<br />
beginning of 1996), they currently represent less than 18 months of projected<br />
payouts. The system, in other words, is not pre-funded like a private annuity or<br />
pension plan, but rather relies on pay-as-you-go financing. Today's retirement<br />
benefits are paid mostly by today's workers' contributions, an arrangement that<br />
has functioned successfully for 60 years.</p><br /><p>Measured against the goal of reducing old-age poverty, Social Security has<br />
been a notable success. It deliberately transfers resources from those with high<br />
lifetime earnings to those with low lifetime earnings. In 1996, each dollar of<br />
average (indexed) monthly earnings up to $437 translates into 90 cents of<br />
monthly retirement benefit. By contrast, each dollar of average monthly earnings<br />
between $437 and $2,635 adds only 32 cents, and each dollar of extra average<br />
monthly earnings beyond that adds only 15 cents. No private saving plan,</p>
<p>annuity, or whole-life insurance policy has this redistributive, antipoverty<br />
feature. </p><br /><p>Social Security has profoundly improved the economic well-being of older<br />
Americans. Nearly 30 percent of the elderly were poor as recently as 1967, more<br />
than twice the overall poverty rate. Social Security retirement benefits were<br />
raised substantially during the late 1960s and early 1970s, and poverty among<br />
the elderly plummeted. By 1974, the elderly poverty rate had fallen to half of<br />
its 1967 level, and it has been below the overall poverty rate since 1982.<br />
Social Security benefits provide over 80 percent of the income of the poorest 20<br />
percent of elderly households (and nearly 80 percent for the next quintile),<br />
compared to only 20 percent of income for the richest elderly quintile. </p><br /><p>Unfortunately this rosy record cannot continue without another round of tax<br />
increases, benefit cuts, or more fundamental changes. Precisely because it is so<br />
generous, at a time when people are living longer, Social Security is<br />
outstripping its means. And the fact that many people have come to expect<br />
generous public benefits may have discouraged private and pension savings as<br />
well.</p><br /><p>Some analogize Social Security to a mandatory chain letter. As long as the<br />
economy was growing rapidly and the ratio of workers to retirees was large, the<br />
burden of financing ever more generous benefits could be passed along to the<br />
next generation. But as the population ages, the ratio of Social Security<br />
contributors to beneficiaries has declined, from 5 to 1 in 1960 to 3.3 to 1<br />
today and projected to only about 2 to 1 by the year 2030. In an aging<br />
population with a pay-as-you-go retirement system, successive cohorts stand to<br />
receive a declining "rate of return" on their lifetime contributions.</p><br /><hr /><br /><h3>THE VANISHING WINDFALL</h3><br /><p>Past and current cohorts of retirees have received much more back from<br />
Social Security than they and their employers contributed, even allowing for a<br />
reasonable rate of return. For example, a man with average lifetime earnings who<br />
retired at age 65 in 1980 could expect to receive in Social Security retirement<br />
benefits 3.7 times more than his contributions would have generated, had they<br />
been invested in low-risk government securities. For a similar woman, the ratio<br />
was even higher4.4 timesbecause of her longer life expectancy.<br />
Thanks to the progressive benefit formula, these ratios were even greater for<br />
lower- income people. But in the past, even high earners received benefits more<br />
than 3 times the value of contributions made on their behalf. The income<br />
redistribution within cohorts of retirees was dominated by the income<br />
redistribution between cohorts (from workers to retirees).</p><br /><p>As the ratio of workers to beneficiaries continues to decline, so will the<br />
ratio of Social Security benefits received to taxes paid. For example, most<br />
workers reaching age 65 in 1995 can still expect more in lifetime Social<br />
Security benefits than an alternative low-risk investment (earning a 2 percent<br />
real interest rate) would have provided, according to Eugene Steuerle and Jon<br />
Bakija of the Urban Institute. Within ten years, however, many retirees<br />
(primarily higher earners) can expect to receive less than a 2 percent real rate<br />
of return on their Social Security contributions. Although one-earner couples<br />
and those in the bottom half of the earnings distribution will continue to do<br />
well, there will be many more recipients who may judge their mandatory Social<br />
Security contributions to be a poor investment relative to what they could have<br />
done on their own.</p>
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<p></p></center><br /><hr size="1" /><p></p><p>The maturing of the system has made its redistributive aspect explicitand<br />
thus politically vulnerable. In the past, the intergenerational income transfersfrom<br />
workers to retireeswere so generous that they were a better deal than<br />
conventional low-risk investments, even for the affluent. But as that windfall<br />
gradually disappears, Social Security ceases to be so attractive to higher<br />
income earners, and its political base begins to splinter along income lines.</p><br /><p>Social Security is also faulted for depressing the national saving rate,<br />
since it gives people a retirement check that is actually financed by transfers<br />
from the working population, rather than by interest on accumulated savings. The<br />
average 1996 Social Security recipient, with annual benefits of $7,700, would<br />
need a savings account (paying 5 percent interest) in excess of $150,000 to<br />
collect that much in interest. But no such savings account exists. </p><br /><p>Ultimately, future retirees' consumption will depend on the productive<br />
capacity of the economy. Increasing the economy's future productive capacity, in<br />
turn, requires higher rates of saving and investment. Sponsors of more radical<br />
reform argue that if Social Security were turned into a partly or wholly funded<br />
system, it could become a net contributor to savings. But the more that Social<br />
Security is revised to emphasize nontraditional goalshigher individual<br />
investment returns and more freedom of choicethe more it loses its<br />
redistributive character. </p><br /><hr /><br /><h3>IS THERE A CRISIS?</h3><br /><p>Social Security is newly vulnerable because it is no longer a good deal for<br />
all, and because its projected revenues are inadequate to pay promised benefits.<br />
Around 2013, benefit payments will exceed payroll taxes. By about 2019, benefit<br />
payments will exceed all sources of OASDI revenues, including interest on the<br />
Trust Fund. After this date, less than 25 years from now, Social Security would<br />
have to sell Treasury securities to pay benefits and Trust Fund assets would<br />
begin to decline. If no further changes were made, Trust Fund reserves would be<br />
exhausted by about 2030, when baby boomers will be between 65 and 85 years old,<br />
and Social Security would be unable to pay the benefits retirees are due.<br />
Obviously, this will not occur, because Congress will act before then, either to<br />
raise taxes or change the program's benefit structure.</p><br /><p>Over the next 75 years (the traditional accounting horizon for Social<br />
Security), the projected deficit will average about 2.2 percent of covered<br />
payroll per year. In other words, a payroll tax increase of 2.2 percentage<br />
points (i.e., from 6.2 to 7.3 percent for both employers and employees) could<br />
eliminate the current 75-year deficit. But solving the current 75-year deficit<br />
does not leave the system in true long-term balance, since the red ink rises<br />
again as the 75-year window moves forward.</p><br /><p>When the system was founded, payroll taxes totaled 2 percent on the first<br />
$3,000 of annual earnings. By 1960, taxes had risen to 3 percent of the first<br />
$4,800, and by 1980, to 5.08 percent of the first $25,900 (excluding the<br />
Medicare tax begun in 1966). Since then, the OASDI tax rate has been increased<br />
several more times, reaching the current 12.4 percent in 1990, on covered<br />
earnings that are indexed annually and are currently capped at $62,700. Some of<br />
these increases were enacted to pay for expanded benefits, but for the most part<br />
they reflected a gradual decline in the ratio of workers to retirees.</p><br /><p>In 1983, for the first time, some of the balancing occurred on the benefit<br />
side. Up to one-half of Social Security benefits were subjected to federal<br />
income taxation for high-income recipients, and the normal retirement age of 65<br />
was scheduled to rise slowly to 66 and then to 67, beginning with those turning<br />
62 in the year 2000. The 1983 amendments returned the system to long-range<br />
(75-year) actuarial balance. But the system is back out of balance only 13 years<br />
later, both because long-range economic and demographic assumptions are now less<br />
favorable than in 1983, and because the 75-year accounting period moves forward<br />
every year, each time replacing a current surplus year with a future deficit<br />
year. </p><br /><hr /><br /><h3>RADICAL REFORM?</h3><br /><p>In 1994, President Clinton appointed a Social Security Advisory Council, as<br />
is done every four years. The committee, representing business (three members),<br />
labor (three), the self-employed (one), and the public (five), was chaired by<br />
University of Michigan economics professor Edward Gramlich. The council was<br />
directed to focus on the system's fiscal stability. </p><br /><p>Reflecting the diverse views of its membership and the nation, the council<br />
has proposed three very different visions of Social Security reform. The first,<br />
termed the Maintenance of Benefits plan, is championed by Robert Ball, a former<br />
Social Security Commissioner, and five other members of the 13-person Advisory<br />
Council. It follows past tradition by raising revenues to meet current benefit<br />
obligations within the system's current structure. In a departure from the past,<br />
however, this plan also recommends investing up to 40 percent of Trust Fund<br />
reserves in private capital markets. </p><br /><p>The second proposal, labeled the Individual Accounts plan, is favored by two<br />
members of the council, including Chairman Gramlich. This approach, similar to<br />
legislation proposed by Senators Bob Kerrey and Alan Simpson, trims benefits and<br />
adds revenues, and then adds a controversial new componentmodest<br />
individual defined contribution accounts within Social Security, funded by an<br />
increase in the payroll charge, over which participants would have limited<br />
investment discretion.</p><br /><p>The remaining five members, led by Sylvester Schieber, a business<br />
representative to the council, are championing a third option, called the<br />
Personal Security Account plan. This would replace the current Social Security<br />
system with a very different one, with flat benefits independent of earnings,<br />
and large mandatory personal retirement accounts, funded by a diversion of part<br />
of the current payroll tax, and held and managed by individuals. </p><br /><p>Ball's Maintenance of Benefits plan maintains the currently legislated<br />
schedule of benefits, and finds new revenues needed to pay for them, from three<br />
sources: additional federal taxation of Social Security benefits and the<br />
diversion to the OASDI Trust Fund of the income tax receipts currently<br />
supporting Medicare; a 2 percentage point increase in the combined<br />
employer-employee payroll tax rate in the year 2050; and the allocation of up to<br />
40 percent of Trust Fund reserves to the equity market, which, over the long<br />
run, has enjoyed a higher rate of return than government bonds. This proposal<br />
envisions no individual accounts and no benefit cuts beyond those already<br />
legislated.</p><br /><p>The other two plans reduce future Social Security benefits. Gramlich's plan<br />
reduces benefits across the board, both by increasing the normal retirement age<br />
to age 67 by 2012 and then indexing it to changes in longevity, and more so for<br />
high-income workers through changes in the benefit formula. It then goes a<br />
significant step further by proposing an additional mandatory payroll charge1.6<br />
percent of covered earningsto be dedicated to individual retirement<br />
accounts. Although the funds in these accounts would be held by Social Security,<br />
individuals would make their own investment choices from a limited set of broad<br />
options, such as bond funds and equity indexes. </p><br /><p>At any time after age 62, retirees could claim an indexed annuity from<br />
Social Security, based on the total accumulations in the account; the funds<br />
could not be withdrawn in a lump sum. These individual accounts can be either be<br />
viewed as a modest beneficial addition to the current system, an encouragement<br />
to national saving, and a popular (and perhaps the only) way to raise the<br />
payroll taxor as a major change in the redistributive philosophy of Social<br />
Security, one that might open the door to more significant changes later.</p><br /><p>Schieber's option proposes more significant change in the system. Current<br />
earnings-related retirement benefits would be replaced by a low, flat-rate<br />
benefit, available to all workers with at least 35 years of contributions,<br />
regardless of their earnings histories. In today's dollars, the annual benefit<br />
would be about $400 per month, about two-thirds of the poverty level for an<br />
elderly individual, and significantly less than today's average Social Security<br />
benefit. (Prorated flat benefits would be paid to those with 10 to 35 years of<br />
coverage.) The mandatory personal security accounts (PSAs) would be funded by<br />
payroll taxes of 5 percent of covered earnings, diverted from the current 12.4<br />
percent payroll tax. (About 2.4 percentage points would be needed to finance<br />
continuing survivors and disability programs; the individual's half of the<br />
remaining 10 percent would be allocated to the PSA, and the employer's 5 percent<br />
to the flat benefit.) </p><br /><p>The PSAs would be owned and invested by individual participants, with some<br />
regulation over the types of funds people could hold. Accounts could be claimed<br />
only after age 62, but then could be withdrawn as a lump sum or converted into<br />
an indexed annuity provided by the Social Security Administration. Under this<br />
third plan, the redistributive and individual equity components of the current<br />
system would be completely separated. Workers aged 55 or older (in 1998) would<br />
continue under the current system, and enjoy benefits as currently promised,<br />
while workers under age 30 would be covered entirely under the new system. Those<br />
between 30 and 55 would receive hybrid benefits reflecting their accrued rights<br />
under the current system at the time of transition and prorated flat benefits,<br />
as well as the proceeds of their personal security accounts. Even with the<br />
significant Social Security benefit cut proposed, diverting 5 percent of current<br />
payroll taxes leaves a significant unfunded liability. Therefore, additional<br />
revenues equal to about 1 percent of aggregate consumption (or about 1.5 percent<br />
of covered payroll) over the next 70 years would be required to cover the<br />
flat-rate benefits.</p><br /><p>Despite their significant differences, all three proposals contain common<br />
elements worth noting. They all recommend the maintenance of a mandatory,<br />
universal, public social insurance program, with retirement, survivor, and<br />
disability benefits. They all maintain a progressive benefit structure, with net<br />
transfers toward those with low earnings histories. Each envisions additional<br />
taxation of Social Security benefits, with the eventual inclusion of all Social<br />
Security benefits (in excess of contributions already taxed) in taxable income.<br />
All recommend mandatory Social Security coverage of all new state and local<br />
government employees (as is true in some states already).</p><br /><p>All three plans also favor increases in the normal retirement age beyond 65,<br />
and two of them then index the age to changes in longevity. None proposes<br />
means-testing benefits or indexing Social Security benefits at less than the<br />
cost of living. All three eliminate the current 75-year Social Security<br />
imbalance, and go beyond this to stabilize the ratio of the Trust Fund reserves<br />
to annual expenditures between 2050 and 2070, the last two decades of the<br />
current planning horizon. Finally, all three plans rely on private-sector<br />
investments to generate additional revenues for future retirees.</p><br /><p>This is the last quadrennial Social Security Advisory Council. The Social<br />
Security Administration is now a quasi-independent agency, and it will be<br />
advised by a permanent advisory board. How will this last group's efforts be<br />
judged? Some believe that this Advisory Council's lack of consensus will doom<br />
its efforts to irrelevancy. But it may well turn out to be just the reverse. By<br />
offering three diverse proposals, the council has clarified profound political<br />
and philosophical differences about the future of Social Security, which will<br />
make for a more informed national debate.</p><br /><hr /><br /><h3>PERILS OF PRIVATIZATION?</h3><br /><p>The two individual-account plans would create an explicitly double-deck<br />
system, with a lower deck focusing on income adequacy and income redistribution,<br />
and an upper deck generating benefits directly related to contributions. The<br />
lower deck is to be a defined benefit plan, while the upper deck is a defined<br />
contribution plan, like a 401 (k). The overall degree of redistribution in the<br />
system would depend on the generosity of the lower deck and on the returns<br />
earned on investments in the upper deck.</p><br /><p>With privatization, Social Security's twin goals of income adequacy and<br />
individual equity would be separated and become more explicit and transparent.<br />
Over time, the commitment of more affluent taxpayers to the lower deck of the<br />
system might erode. The system as a whole might become far less redistributive.<br /></p><br /><p>Questions also remain about the effect of privatization on work, saving, and<br />
the distribution of income and risk. Privatization might increase the incentives<br />
to work at later ages and therefore delay retirement decisions, since one's own<br />
contributions would be more directly linked to personal pension accumulations<br />
and eventual benefits. Under the current system, working longer and earning more<br />
often increases Social Security taxes more than it does eventual benefits. Given<br />
the increasing health and longevity of older Americans, this change would be a<br />
plus.</p><br /><p>Would individuals save more or less under these privatization plans than<br />
they now do? Under the Individual Accounts and the Personal Savings Accounts<br />
plans, total tax collections would rise, directly financing an increase in<br />
saving. Of course, those already preparing for retirement on their own could<br />
offset this mandatory change by saving that much less in other ways. Under both<br />
of these plans, having more personal control over a sizable portion of their<br />
payroll taxes might make individuals feel more confident about the future. Some<br />
might respond to this by saving less. On the other hand, allowing people some<br />
control over their retirement portfolios might improve financial literacy,<br />
generate more serious thought about retirement planning, and thereby increase<br />
personal saving rates.</p><br /><p>Many other important details remain to be clarified, particularly under the<br />
PSA approach. Could the accumulations be tapped for medical, home foreclosure,<br />
or other emergencies prior to retirement? Who bears the ultimate risk of poor<br />
investment returns, either because an individual chose badly or because the<br />
economy as a whole performed poorly? If lump-sum withdrawals are permitted at<br />
retirement, what happens to those who squander these savings and then find<br />
themselves in need? If annuities were offered but not required, how would we<br />
deal with the adverse selection problem, that those choosing the annuity option<br />
would tend to be that subset of the elderly with the longest life expectancy?<br /></p><br /><p>The concerns are both economic and political. Although equities, on average,<br />
have outperformed bonds in the postwar period, there is no guarantee that the<br />
future will repeat the past. Novice or poorly educated investors may fare poorly<br />
with increased choice and exposure to financial markets. Some critics worry that<br />
there will be inadequate public education and regulation to avoid swindles and<br />
scandals. Lump-sum allocations may induce some elderly to consume their assets<br />
too quickly and then outlive their means, which is less likely with the current<br />
mandatory indexed annuity provided by Social Security.</p><br /><p>The political future is even more problematic. Under the current Social<br />
Security system, both the income adequacy and individual equity components are<br />
intertwined in one complex set of payroll tax and retirement benefit<br />
regulations. This single system has commanded broad political support. Under<br />
privatization, the antipoverty component would be explicitly separated from the<br />
rest of the system, where it could survive or wither, depending on the political<br />
climate ahead. Privatization itself would contribute to a less universalistic<br />
conception of the program. Critics of privatization fear that, once on its own,<br />
the minimum benefit could lose its political support, and the antipoverty gains<br />
of the past decades may be lost. </p><br /><p>Sponsors of privatization argue that everyone will be better off, because of<br />
increased saving and the higher rates of return to be earned in private capital<br />
markets. But prospective retirees at the lower end of the income distribution<br />
had hoped to be the beneficiaries of a highly progressive Social Security<br />
benefit structure. Under the PSA plan, they would receive a smaller basic<br />
benefit, and despite the personal savings accounts, some will end up losers.<br /></p><br /><p>In the past, defenders of Social Security have relied on its universalism,<br />
bolstered by the fact that Social Security was a good financial deal for nearly<br />
everyone, despite its redistributive character. This was widely appealing as<br />
long as it lasted, but demographic changes are making the universalism harder to<br />
sustain. </p><br /><p>It is inevitable that stabilizing the Social Security system will require<br />
some combination of tax increases and benefit delays or cuts, and all three<br />
plans acknowledge this. If the goal is simply to render the Social Security<br />
system solvent, the Ball plan does the trick, mainly by raising taxes. The<br />
Gramlich and the Schieber plans also stabilize the system's finances, by raising<br />
taxes and reducing benefits, but introduce a new philosophical twistpersonal<br />
retirement accounts. These individual accounts are intriguing and should not be<br />
dismissed out of hand. They have the potential of increasing saving incentives,<br />
while giving people more control and responsibility for their own economic<br />
future. They may help rebuild young workers' confidence in what they believe to<br />
be an insolvent system by reducing the burden of the public promise in the<br />
future. Yet privatization, by explicitly separating income redistribution from<br />
earnings replacement, might significantly weaken Social Security's important<br />
antipoverty role.</p>
<p><br /><br /><!-- dhandler for print articles --></p></div></div></div>Wed, 19 Dec 2001 19:17:58 +0000141245 at http://prospect.orgJoseph Quinn